Monday, February 1, 2016

Renting vs. Buying

Our friends at Marginal Revolution have a nice post about renting vs. buying.  Most of it is about the benefits and costs of the enormous tax subsidies that bias the decision towards buying.  Economists think the subsidy destroys wealth because it prevents people from moving closer to better jobs, and needlessly subsidizes the rich.

But some of the advice is aimed at would be homeowners
Housing is overrated as a financial investment. First, it’s not good to have a significant share of your wealth locked into a single asset. Diversification is better and it’s easier to diversify with stocks. Second, unless you are renting the basement, houses don’t pay dividends. Stocks do. You can hope that your house will accumulate in value but don’t count on it. Indeed, you should expect that as an investment your house will appreciate less than does the stock market. You didn’t expect to get a great investment and a place to live in the meantime did you?

Finally, they recommend buying a smaller house close to where you work because commuting is really inefficient and the compensating differentials reduce the value of small houses (so buy one).

9 comments:

  1. I agree that housing is not a good example of a financial asset as compared to investment in stocks, unless of course, you are purchasing houses as rental income properties, in which the rent received should provide some level of income in addition to financing the mortgage and maintenance costs. In a perfect world, all of your tenants would pay their rent on time and would respect the home they live in! However, when purchasing your own home, I believe several considerations come into play. Proximity to work and schools, as well as local shopping and entertainment. The size of home and a desirable location are also considered to be important. A smaller home and yard are much easier to maintain and more efficient to heat/cool when necessary. The housing market differs by location. Small homes in or near locations with higher paying jobs are usually higher priced than a comparable or larger home further away. Being able to afford the home you choose is also important whether you look at your home as an asset or a necessity. For those that work in a city, renting may be the only affordable option in order to live close to work. However, many would prefer to own a home and commute, which is inefficient. Houses are getting bigger and fancier, and more expensive, and more people are living beyond their means just to own a large home. If you prefer to buy rather than rent, a smaller house close to work is the most economical choice. Either way, a home is your home whether you own it or rent it.

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    1. I too agree that a home is not a great financial investment I the purest sense. However, what are the Asians that many people buy their homes? Are they to financial or lifestyle in nature?

      I would argue that for most people, the real Redon that they buy a home is to give a sense of long term freedom and stability. By owing a home, you are beholden to no one other than the bank and taxman. When you rent, you are at the mercy of the promptly owner. Sure you have a lease, but what happens when that lease runs out? You either re-negotiate a lease (presumably at a higher payment) or you move. If you want to have a relatively fixed housing expense without having to move for any other reason than your choice, I say home ownership is better.

      Another lifestyle issues is choice. By choice, I mean the choice of what to do with the actual building and space that you are living in. As a renter, most landlords will prevent you from making any changes to the layout and decor of the property that you are renting. Do you kids and want to put up a swing set in your yard or add on a deck or a pool? Good luck if you are renting. As a homeowner, you have the freedom of modifying your property in any way that you would like as long as you can afford it and it is writhin the limits of the building codes.

      From a financial perspective, unless you have a large deposit, I agree that a home is a poor investment. When you look at your mortgage disclosure statement, you can see how much that you are going to pay interest over the term of your loan. I remember when I first bought my house, I was shocked that over the course of the loan I was basically paying double the purchase price when all was said and done due to the interest. This did not take into account taxes or utilities. It is hard to make the numbers add up from a financial perspective when you factor these things in. However, if I had a larger down payment and could shorten the term of the loan, then perhaps the numbers would be more in my favor.

      This then begs the question of opportunity cost for the money that is tied up in the home when you buy. What else could you do with the money from an investment perspective. Could you put it to work and turn it into a profit, perhaps, however, you will still have housing expenses over the same term.

      For me, my home is indeed an investment. It is an investment in my family and my freedom of choice. I have chosen to refinance and add on an addition as well as many upgrades in my yard. I did this without moving and I have actually lowered my mortgage payment in the process due to favorable mortgage rates. So, at the end of the day, my home investment is very rewarding to me personally and is worth the cost. I have not factored in my return on investment from a financial perspective, because I do not plan on moving for many years.

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  2. When looking at renting vs buying in terms of home ownership, it is easy on the surface to make the argument about commuting, home value depreciation and appreciation and the costs and risk that come with home ownership. One thing that I think is also important to take into consideration is geographical location. Home and rent values change from not only state to state but also county to county as well. Looking further into that argument, living on Long Island, it is a commuter area where people have to drive to work most likely or a train station to get to the city. On Long Island, the price of homes are very high as are taxes, compare this to an area in say Nebraska, Texas or down south and you will see that not only home but taxes associated with those homes and taxes are also high on Long Island compared to other areas. That being said, you also have to look at the rent values associated with those areas. On Long Island, rent can almost approach the same price as a mortgage, so when looking at it that way, you are building equity when buying whereas with rent in the similar range of a mortgage, you have nothing to show for the money spent.

    I do believe that having all your equity in one asset as the reading states is risky, however given the recent volatility of the market, you are risking your funds based off your portfolio. Like the stock market, the housing market is ever changing over the standard 30-year mortgage. Both come with the risk of losing money, and should you need to move, the home would need to be sold or rented to move out of state or to another area within state.

    One thing I do agree with is where the article states renting an apartment within the home in order to pay dividends. Renting an apartment within the home will bring in added income that can be used to counter the mortgage cost. This is not uncommon on Long Island since mortgages due to home values is often high. In doing so, you are creating less of a financial burden on yourself to meet the mortgage number allowing money to either invest or save.

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  3. The decision to own versus rent is very much a lifestyle decision as it is an economic decision. In most cases, it is driven by household formation – people getting married, starting families and being able to afford to do so.

    Less than 40 percent of people under 35 years of age own homes, over 60 percent of people over 35 years of age own homes, and over 80 percent of people over 65 years of age own homes.

    Other factors that are not as prominent but as apparent are whether you look at your home as an investment and can you handle the stress of home ownership. If it's really important that you look at your home as an investment, you might want to rethink your future living scenarios.

    Homeowners are used to their homes being a reservoir for wealth – something to liquidate in retirement or leave for your children. That’s no longer the case. As we have seen in recent years, houses can go down in price as well as up.

    Something else to consider, since it's one of the biggest financial decisions most people will ever make, one huge factor to consider when buying a home is stress. I hear it from my cousin every time I see him , “God this house is killing me”.

    A landmark stress study conducted in 1970, ranks many events that go along with buying a home in the top 43 most stressful circumstances in life. Four events are specifically home-related: change in financial state (No. 16), large mortgage or loan (No. 20), change in living conditions (No. 28) and change in residence (No. 32). Stress overload can lead to missed payments, which can result in destroyed credit or even losing the home.

    http://money.usnews.com/money/personal-finance/articles/2013/12/13/renting-vs-buying-a-home-which-is-smarter

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  4. Purchasing a home as always been known to be a great investment, however over the past few decades, home prices has nearly doubled. There are other factors/costs to consider when thinking on purchasing a home, such as real estate taxes, insurance, closing costs, upkeep of the property, maintenance of the house structure and land. If you are renting the landlord takes care of all of these expenses. There is flexibility in owning a home, as it is your property, so you are free to add upgrades, whereas renters so not have such flexibility.
    I remember looking for an apartment a few years ago, and thought it would be a better idea to purchase a home because I was putting down a security deposit and firsts month rent towards my apartment. I thought it would be a good investment. After meeting with someone at the bank they advised me that it wasn’t a great move at the time to buy a home because I didn’t have enough money for the down payment and it wouldn’t be a good investment in the long run. Renting has its perks, as I don’t have to worry much about upkeep and maintenance of the property. I am still unsure if purchasing a home is in the cards for me, as it is a huge investment.
    Reference:
    http://www.feedthepig.org/get-started/spending/rent-vs.-buy#.VsAnDFK6-zE
    http://www.forbes.com/sites/billconerly/2013/11/11/should-you-buy-a-house-or-rent-the-economics-of-homeownership/2/#74c054f7754b

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  5. There are pros and cons to both renting and buying. Ultimately, it is very individualized on which option is best. Buying a home is an extreme investment. It is not uncommon for many people to overlook the responsibilities of buying and owning a home. Without having a large down payment, you are likely to be paying an extra PMI (private mortgage insurance), which is essentially just an extra payment for you that does not help in the long run and you end up paying even more. All costs, variable and fixed, must be taken into consideration. Buying, as opposed to renting, requires you to do your own maintenance, yard work, etc. This is a larger cost and burden to you, which may not be as much of a benefit in the long run if you are not ready for it. Owning a home does help to build your credit and offers a tax break, but it is not the right decision for all.

    Irwin, Neil.17 June 2015. After an era of ups and downs, home prices return to sanity. Accessed 14 February 2015 at: http://www.nytimes.com/2015/06/18/upshot/after-an-era-of-ups-and-downs-home-prices-return-to-sanity.html

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  6. Renting Vs. Buying is a great debate. Buying a house is an asset rather than renting and having no property after the lease is up. While making investments in the stock market may be more profitable, a house may be more logical for a family. Some people are able to flip homes by buying cheap homes and doing the work on their own then selling it. This results in a profit if they are able to sell it for more than what they bought it for and more than what they put in to fix it up. Renting is logical if someone doesn't have a secure job or for someone who may not be able to pay for utilities or the upkeep of appliances. Location is crucial for people and their jobs which is also a factor in where they live. If their job is in a city, a house may not be an option and renting would be closer to work rather than commuting far from a suburb.

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  7. When it comes to renting versus buying, here is my take using a house as an example: comparing the total cost of renting with the total cost of buying, I first look at the cost of renting starting with the monthly rent then renter's insurance and a refundable security deposit (just 3 cost elements.)

    Calculating the cost of buying, I have to consider the purchase price, the initial down payment, the buyer closing costs, the monthly mortgage payment and other recurring costs such as maintenance, property taxes, insurance and the final mortgage payment. If I decide to sell the house, I will have to deal with the cost of sales and seller closing costs. These analysis provide an obvious gist that renting is favorable. Besides, it’s not good to have a significant share of your wealth locked into a single asset like a house. Diversification is better and it’s easier to diversify with other instruments such as stocks (Tabarrok,2016)

    Another problem with buying a house is that home ownership can lock you up to a location making it very hard to move for jobs - when jobs disappear and home prices fall, instead of moving, people hold on for too long just hoping that things will get better.

    Germany is a wealthy country and majority of Germans don’t buy their homes. They rent, because they believe that high home-ownership damages the labor market. It’s troubling that United States' higher home ownership prevails and its rate predicts higher unemployment rates.

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  8. Rent-or-buy? That is the question. The emotional answer is different than the economical one. The conventional wisdom was always to buy a house as soon as you have enough money saved because it is good equity that builds your credit, but “that “wisdom” turned lots of people upside down in the past decade” (Connerly, 2013). Connerly also argues that the average home appreciation is 4.5% per year, and the average long-run return of a stock is 9.8%, which would suggest home ownership is not a great investment. Many economics argue diversification of assets through stocks would be a better investment than home ownership.

    When it comes to mortgage interest, everyone always says it is deductible on your taxes. However, it “is frequently overrated,” and “the deductibility doesn’t offset the fact that you are paying someone interest. It’s an expense, and you are worse off because of it” (Connerly, 2013). Furthermore, if all your expenses are lower than the standard deduction, which is $6,300 for an individual or $12,600 for married filing jointly, it does not matter what the interest is because you cannot itemize it (Bell, 2015). Again, to use Connerly’s word, overrated.

    Now that I have created an argument against homeownership, there are still the psychological reasons to purchase a home, including a sense of ownership, freedom, and knowing you are paying your mortgage, not your landlord’s. Furthermore, purchasing a smaller, more affordable home to work can actually be a good economic investment because you are not expending more of your income than rents, and you are building equity.

    Bell, K. (2015). Standard tax deduction amount. Bankrate.com http://www.bankrate.com/finance/taxes/standard-tax-deduction-amounts.aspx#ixzz429Yljwky

    Connerly, B. (2013). “Should You Buy a House or Rent? The Economics of Homeownership.” Forbes. http://www.forbes.com/sites/billconerly/2013/11/11/should-you-buy-a-house-or-rent-the-economics-of-homeownership/#6390a06c7acd.

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